A federal appeals court on Friday struck down a Securities and Exchange Commission rule granting outside investors proxy access rights, saying the agency had failed to consider the economic impact of the rule.
“We ... hold the Commission acted arbitrarily and capriciously for having failed once again … adequately to assess the economic effects of a new rule,” Judge Douglas Ginsburg wrote in the D.C. Circuit court’s opinion. “Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.”
That’s a pretty serious rebuke for the SEC.
The case was the latest in a long fight about the way in which shareholders receive information about potential nominees for the boards of companies. Under the usual way of doing things, companies send out their nominees for board membership to shareholders and outside shareholders who want to name their own nominees have to pay for the expense of sending out another proxy statement.
Self-styled advocates of shareholder democracy have long argued that this entrenches management and deprives outsider shareholders of their rights as owners. Dodd-Frank authorized the SEC to force companies to open up the process, allowing outside shareholders access to company sponsored proxies. The rule the SEC adopted gave proxy access to any shareholder who owns at least 3 percent of the common stock.
The key to understanding the ruling striking down the SEC’s rule is to understand that the court saw something the SEC missed: Not all shareholders are alike. In particular, activist investors of various sorts may have interests that strongly diverge from passive investors with diversified portfolios. (For a more detailed discussion of the legal issues involved, click here and here.)
A union-dominated pension fund, for example, could use proxy rules to force concessions from management at the expense of other shareholders. The classic example would be a fight over wages. The union could threaten to run its own set of candidates unless management conceded to raise wages. The losers would be the truly independent shareholders.
From the decision:
Notwithstanding the ownership and holding requirements, there is good reason to believe institutional investors with special interests will be able to use the rule and, as more than one commenter noted, "public and union pension funds" are the institutional investors "most likely to make use of proxy access." ... Nonetheless, the Commission failed to respond to comments arguing that investors with a special interest, such as unions and state and local governments whose interests in jobs may well be greater than their interest in share value, can be expected to pursue self-interested objectives rather than the goal of maximizing shareholder value, and will likely cause companies to incur costs even when their nominee is unlikely to be elected.
The court’s decision doesn’t rule out the possibility of the SEC passing a new proxy access rule after considering and responding to the arguments that the court says it ignored here. But at least the ability of special interest shareholders to influence or dominant corporate boards has been forestalled.
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